S&P Is Facing a Bipartisan Backlash in Washington

By

Victoria McGrane

August 10, 2011

Standard & Poor's downgrade of the U.S. government's credit rating has created something few thought possible: a bipartisan consensus in Washington.

Unfortunately for S&P, the rating firm is the one in the crosshairs. Democrats and Republicans in Congress are gearing up to put it under investigative scrutiny and do more to restrict the influence of S&P and its peers in financial markets.

Democrats are particularly angry about S&P's alleged $2 trillion mistake in estimating total federal deficits over the next decade. The firm changed the forecast at the Treasury Department's urging, but went ahead with the downgrade anyway, saying the change didn't greatly affect its analysis.

The Senate Banking Committee staff is gathering information, and "all options remain on the table," including whether to hold a hearing, according to a committee aide.

Rep. Dennis Kucinich (D., Ohio), a member of the House oversight committee, requested documents Tuesday from S&P's parent company, McGraw-Hill Cos., seeking information on whether it could have benefited financially from the credit rater's decision. Another Democrat, Massachusetts Rep. John Tierney, called on Chairman Darrell Issa (R., Calif.) to convene a hearing to investigate "the motivation and decision-making process" that led to S&P's decision.

More substantially, the S&P downgrade could force regulators to move more quickly to lessen the big three rating firms' importance to the financial markets, both in the U.S. and abroad.

The downgrade almost certainly eliminated the chances that Congress will change a provision in last year's Dodd-Frank financial overhaul that requires U.S. financial regulators to purge references to ratings from their rules, analysts say.

U.S. banking regulators have struggled to find an alternative gauge for the creditworthiness of bank assets, particularly in rules governing how much capital institutions need to hold as protection against losses. In almost a year of work, the Federal Reserve, the Federal Deposit Insurance Corp. and the Comptroller of the Currency haven't yet found a solution to propose.

Bank trade groups have been pushing Congress to soften the provision, arguing that any alternative system would be expensive to develop and potentially less effective. John Walsh, acting head of the OCC, has asked several times for Congress to allow regulators the flexibility to keep ratings in the mix of risk measures. But now, "the idea of repealing that provision is off the table," said Jaret Seiberg, a Washington analyst with investment bank MF Global. "It's hard to see any reason why Senate Democrats are going to allow that to proceed."

Rep. Barney Frank of Massachusetts, the top Democrat on the House Financial Services Committee and co-author of the Dodd-Frank bill, said the downgrade shows he was right to restrict the role played by the raters. "They did a terrible job" in the run-up to the financial crisis, assigning triple-A ratings to many mortgage-related securities that quickly plunged in value, Mr. Frank said.

Republican lawmakers have been less critical of S&P's decision but agree that changes are needed. Rep. Randy Neugebauer (R., Texas) said banking regulators have so ingrained ratings into the financial system, they have "almost made it a given that you have to have these ratings. What we're saying is we don't want them totally relying on ratings in making those determinations."

Karen Shaw Petrou, managing partner of advisory firm Federal Financial Analytics, believes the S&P downgrade also will spur U.S. regulators to seek changes to international financial agreements that rely on credit ratings, including the recent capital and liquidity requirements worked out by the so-called Basel Committee.

The ratings firms have consistently said they support efforts to decrease reliance on their ratings in government rules. But some are starting to seek to differentiate themselves from S&P. "Regulation of ratings agencies, understandably, has grown dramatically since the financial crisis," said a spokesman for Fitch Ratings, an S&P rival. "What we would like to see now is for each rating agencies to actually be judged on its own merit."

Fitch, along with the other top rating firm, Moody's Investors Service, reaffirmed the U.S.'s triple-A credit rating after Congress raised the nation's borrowing authority last week.

The Securities and Exchange Commission is working on rules mandated by Dodd-Frank beefing up the agency's oversight of the firms, and it now could come under more pressure to make those rules tougher.

A nightmare for the rating firms: Lawmakers could press the SEC into adopting an idea by Sen. Al Franken (D., Minn.) that the SEC create an independent body to assign a rater to new financial products based on objective criteria, including rating firms' accuracy over time.

Corrections & Amplifications A proposal from Sen. Al Franken (D., Minn.) would have the SEC create an independent body to distribute work assessing new financial products to rating firms based on a specific set of criteria. An earlier version of this article incorrectly described the assignment process as random.

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